Policy Loan

An outstanding policy loan that is not repaid:

1. A.Voids the policyA loan does not void anything on its own. The contract stays in force so long as enough value remains to support the debt, and the loan is simply settled out of what is eventually paid.
2. B.Increases the death benefitThis reverses the direction. The borrowed money has already left the policy, so it is subtracted at claim time rather than added to what the beneficiary collects.
3. C.Reduces the death benefit by the loan balanceCorrect - the loan is deducted from proceeds.
4. D.Has no effect on the death benefitThis ignores the debt. The loan together with its accrued interest is netted against the proceeds, so the beneficiary receives less than the stated face amount.

Why: An unpaid policy loan (plus interest) reduces the death benefit paid to the beneficiary.

A policy's cash value can be accessed by:

1. A.Missing premiumsMissing a payment starts the grace period and puts the policy at risk of lapse; it puts no money in the owner's hands. Even where an automatic premium loan draws on cash value, the money goes to the insurer as premium.
2. B.Changing the insuredNot something an individual life policy generally permits, and it would release no funds in any event. Substituting a life would present a new mortality risk, not a distribution.
3. C.Filing a death claim while aliveA death claim requires proof of death, so there is nothing to file. The living routes to policy money are a loan, a withdrawal where the product permits one, or surrender.
4. D.Taking a policy loan or surrendering the policyCorrect - loan or surrender.

Why: Cash value can be reached through a policy loan or by surrendering the policy.

A policy loan against cash value:

1. A.Accrues interest and reduces the death benefit if unpaidCorrect - flexible repayment, reduces benefit.
2. B.Is tax-deductible interestImports a business or mortgage interest rule into a personal contract. Interest on a personal policy loan is generally treated as nondeductible personal interest.
3. C.Cancels the policy immediatelyA loan leaves the policy in force, which is the entire reason an owner borrows instead of surrendering. Lapse becomes a risk only if the loan and accrued interest eventually outgrow the available value.
4. D.Must be repaid monthlyImposes a bank loan's amortization schedule on something that has none. Repayment is optional, unpaid interest simply accrues, and whatever is outstanding is netted from the proceeds at death.

Why: A policy loan has no fixed repayment schedule but accrues interest, and any unpaid balance reduces the death benefit.

Endymion Blackwood borrows against the cash value of his in-force whole life policy, which is not a modified endowment contract, and never repays the loan. Which statement is correct?

1. A.The loan proceeds are taxable to him as ordinary income in the year that he receives them.Wrong. Borrowing against an in-force policy that passes the seven-pay test is not a distribution at all.
2. B.The insurer must report the loan as a partial surrender once interest begins to accrue on it.Wrong. Accruing interest increases the balance owed but does not convert a borrowing into a withdrawal.
3. C.The loan permanently reduces his cost basis in the policy by the amount that he borrowed.Wrong. Basis reflects premiums paid net of untaxed distributions, and a loan is neither.
4. D.The loan is not currently taxable, and the unpaid balance plus interest reduces the death benefit.Correct. The insurer takes its security out of the proceeds, which is how it lends without triggering a taxable event.

Why: A loan taken against an in-force policy that is not a modified endowment contract is a borrowing, not a distribution, so no income is recognised when the proceeds are received. The insurer secures itself by charging interest and by reducing any death benefit or surrender proceeds by the outstanding balance plus accrued interest. Because nothing has been withdrawn, the cost basis of the owner is untouched by the borrowing. The picture changes if the policy lapses or is surrendered with a loan outstanding, since the loan is then treated as received and any gain becomes taxable.